Arbitrage is the act of buying something at one price, and reselling it at a higher price, usually in a different market, without adding any value to the object. An example of this would be purchasing an antique table at a tag sale for a low price, and selling it to an antique dealer for a higher price.
How Does Arbitrage Work in the Forex Market
In the forex market, one thing of note is that the holder of a particular currency does not typically add the value. For example, if you have USD, and you trade it for the EUR, then after a time the value of the EUR increases, you can trade back to the USD and you will have made a profit. The underlying assumption is that there has been a change to the value of the currency, even though you have not added the value yourself, and therefore this would not be arbitrage trading.
For forex arbitrage, you would make a purchase and sale almost simultaneously, taking advantage of price differences which exist at the time, but which will most likely be corrected by the market fairly quickly.
How to Find Arbitrage Opportunities
There are generally two types of Forex arbitrage trading opportunities which you can find.
The first involves the use of multiple trading accounts. You can take advantage of the pricing difference of a currency between brokerages which sometimes occur. In other words, there are times when two different banks or brokerages are trading the currency at different prices, leading to an opportunity to purchase the one with the lower price and sell to the one with the higher price.
The second involves the use of three currencies. Without going into too much detail, because the currency is valued in pairs, there can be a difference in the price of a currency as valued against two other currencies, which lead to an arbitrage opportunity. This is not as complicated as it sounds and provides a great opportunity based on the way this market works.
How Can You Take Advantage of Them
Although it is possible to monitor and find arbitrage trading opportunities manually, it is easier, more accurate, and far more likely you will find an opportunity if you use a software program designed to look for these types of opportunities. While the details are slightly different from one program to the next, they all basically monitor your account and notify you of these opportunities when they arise.
Arbitrage Trading Strategies
Various kinds of arbitrage strategies are in use depending on the type of markets, time frame, and nature of assets involved. Some of the different types of arbitrage strategies are listed below.
- Index Arbitrage
- Cash & Carry Arbitrage
- Statistical Arbitrage
- Market Arbitrage
- Risk Arbitrage
- Volatility arbitrage
- Spread Trading
- Reverse Cash-and-Carry Arbitrage